From Restriction To Opportunity: RBI's Draft Capital Market Exposure Directions And Their Implications For Bank-financed Acquisitions

On 30 September 2025, Acuity Law published an article titled "Leveraged Buyouts in India: Navigating Financial Strategies Amid Regulatory Challenges" (Click here), where we analyzed the restrictive framework governing acquisition financing under Indian law. Subsequently, on 6 October 2025, we reported (Click here) that, following industry requests, the Reserve Bank of India ("RBI") had proposed a framework to enable acquisition financing in India.

Continuing our close monitoring of the liberalization of India's acquisition financing regime, in this Article, we have sought to examine the key aspects of "acquisition financing" and "bridge financing" under the recently released Draft RBI (Commercial Banks – Capital Market Exposure) Directions, 2025 ("Draft Directions"), which are currently open for public comments. Through these Draft Directions, the RBI has effectively opened the doors of the Indian banking sector to a new avenue of acquisition financing.

The Draft Directions permit commercial banks, excluding Small Finance, Payment, Local Area, and Regional Rural Banks to finance company acquisitions, including leveraged buyouts ("LBOs"). This marks a major shift from the previous reliance on NBFCs and the bond market, with expected ripple effects across M&A activity, bank operations, and market liquidity. By limiting acquisition financing to commercial banks, the RBI aims to channel such transactions through institutions with stronger oversight and capital strength. Separate draft rules for Small Finance Banks notably exclude acquisition finance, reinforcing regulatory distinctions.

The Draft Directions also introduce a layered eligibility and security framework to expand access while maintaining prudent risk controls.

1. Acquisition Finance: Eligibility and Conditions
   1. Eligibility Criteria for Acquiring Companies

The Draft Directions establishes stringent eligibility requirements reflecting the RBI's prudential approach:

1. Listed Entity Requirement: Only listed companies or a step-down special purpose vehicle set up by such company, specifically for the purpose of acquisition, can avail acquisition finance, ensuring transparency and regulatory oversight.
2. Corporate Structure: Acquiring companies must be body corporates, explicitly excluding financial intermediaries such as NBFCs and Alternative Investment Funds.
3. Financial Track Record: Acquiring companies must demonstrate satisfactory net worth and profitability for the last three years
4. Type of Investment: As per the definition of "Acquisition finance" provided for in the Draft Directions, such finance shall be provided to a company for purchasing "all or a controlling portion" of another company. This allows the acquiring company to gain control over operations of the target company, reducing the risk of investment. Further, acquisition finance is only permitted for making strategic long-term investments or acquisitions.

2. Target Company Requirements

To ensure transparency and arm's-length transactions, the Draft Directions impose conditions on target companies:

1. Permissible Target Entities: The target may be a domestic or foreign company.
2. Financial Disclosure History: Annual returns of the target company must be available for at least the previous three financial years.
3. No Related Party Relationship: The target company cannot have a related party relationship with the acquiring company, as defined under the Companies Act, 2013.

3. Financing Structure and Limits

The Draft Directions prescribe specific financial parameters governing the quantum and structure of acquisition financing:

1. 70:30 Financing Structure: Banks may finance up to 70% of the acquisition value, while the acquirer must contribute at least 30% through equity from its own funds.
2. Debt-to-equity ratio: Post-acquisition, the debt-to-equity ratio must not exceed the prudential limits set by the financing bank, subject to a maximum of 3:1 at the acquiring company or SPV/target company level.
3. Exposure cap: Acquisition finance exposure is capped at 10% of Tier 1 Capital, reflecting the higher risk profile of such lending.

4. Security and Collateral Framework

To mitigate credit risk, the RBI mandates a comprehensive security structure:

1. Primary Security: Acquisition finance must be fully secured by shares of the target company.
2. Collateral Security: Additional assets of the acquirer and/or target company may be taken by the bank as collateral against the finance, as per bank policy.
3. Valuation Requirements: Acquisition value must be determined through two independent valuations as prescribed under SEBI regulations.

5. Bank's Role

Banks should put in place an internal policy on acquisition finance which shall inter alia define the overall limit, terms and conditions, eligibility of borrowers, security, margin, risk management and monitoring norms within the framework proposed in the Draft Directions.

2. Bridge Financing

Apart from acquisition finance for strategic M&A transactions, the Draft Directions also address a distinct but complementary funding need of "Bridge Finance". According to Draft Directions, Bridge Finance is a short-term funding to a business for legitimate business use, where the borrower has a clear plan and ability to repay the loan within one year by raising money through equity, debt, or similar instruments. RBI's intent behind permitting Bridge Finance under Draft Directions reflects several key regulatory objectives:

1. Facilitating Short-Term Liquidity Support: Bridge Finance is designed to provide temporary funding to corporates, including financing promoters' stake in new companies, where the borrower company has concrete plans to raise permanent capital through equity, debt, or hybrid instruments. This addresses legitimate working capital needs during transitional periods.
2. Risk Mitigation Through Time Constraints: By capping the tenure at a maximum of one year, the RBI ensures that such financing remains truly transitional in nature and does not become a permanent funding arrangement, thereby limiting exposure duration and associated risks.
3. Prudential Framework for Capital Market Exposure: Bridge Finance is also considered as a credit exposure for calculating Capital Market Exposure (CME) limits for lending banks.

Conclusion: A Measured Liberalization

The Draft Directions on acquisition financing seeks to balance liberalization with prudent safeguards, enabling domestic banks to shift from passive observers to active players in M&A. The key challenge lies in execution, whether banks strengthen governance and risk controls or pursue aggressive growth.

The framework marks India's first step in liberalizing acquisition financing and as markets mature, future updates may include:

1. Expansion to unlisted companies with appropriate safeguards.
2. Relaxation of profitability requirements for specific sectors or transaction types.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.